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Investing, Stocks  | April 25, 2019

Even as the stock market hits new highs, there’s discernible negativity toward the technology sector. That sets up the classic “wall of worry” for these stocks to climb — which makes them a buy.

Below, a few experts with great records in technology weigh in on the false fears, and offer some of their favorite names at the moment.

False Fear No. 1: The Earnings Slowdown

Earnings growth at S&P 500 companies will be sluggish at best for the first two quarters of this year. Performance is getting hit by a pullback in business activity and capital spending because of worries about the economy, trade wars, and Brexit. All of this hits sentiment on tech, one of the most economically sensitive groups.

But these worries are overdone, because the economic outlook is not that bad. “The U.S. economy appears to have stabilized after a shaky start to the year,” says Mark Zandi, chief economist of Moody’s Analytics. “President Trump may soon strike a deal with the Chinese to end his trade war with them, and that is lifting spirits.”

China’s use of monetary easing, tax cuts, and infrastructure spending appear to be kicking in. And the decision to delay Brexit has reduced the potential damage from a no-deal Brexit — at least until October.

False Fear No. 2: Expensive Unicorns

Unicorns — private companies worth $1 billion or more — aren’t what they used to be. They look overpriced, and it shows when they hit the market.

LYFT LYFT, for example, fell 28% after it debuted in a March initial public offering. With SoftBank SFTBY,   leading the charge, there’s too much capital chasing too few names in the pre-IPO arena. “Some of the IPO valuations are hard to get your mind around,” says Eric Marshall, portfolio manager and head of research at Hodges Capital Management.

So while a lot of innovative tech companies are due to IPO this year, they won’t create the tech-sector buzz that IPOs normally generate. “Lyft has obviously cast a pall on everybody,” says Tom Vandeventer, portfolio manager of the Tocqueville Opportunity Fund TOPPX, which handily beats competing funds over the past three to five years, according to Morningstar. “Because unicorns are coming to the market later than normal, a lot of the returns have been realized by the private-equity investors.”

The pushback: He’s right. But does anyone really care, outside of the tech millionaires inside these companies, and their bankers? After all, more mature tech companies that have been public for a while will continue to generate interest by posting nice earnings growth.

Besides, IPOs are way overrated. You don’t have to participate in every one right away. In fact, a good strategy is to do the opposite and avoid them all until they turn into “busted IPOs” which means they trade significantly below their debut prices. This happens to a lot of IPOs, so it is worth being patient.

“You don’t have to buy on day one. You don’t have to buy in year one. Wait for the right moment,” says Kevin Landis who manages the Firsthand Technology Opportunities Fund TEFQX. This ability to be patient probably helps explain why his fund beats competing funds by 3.7 percentage points annualized over the past five years, and 2.7 percentage points over the last 10 years, according to Morningstar.

False Fear No. 3: Rich Valuations

Many investors worry that the hottest areas of tech — like software — look overvalued. But the fears are misplaced. “We are talking about companies that are growing their top lines at 25% to 40% and expanding their margins,” says Vandeventer. What explains this, in a fairly sluggish 2% growth economy?

Customers want to keep spending on software that helps them manage communications, employees and payroll; do software analytics; use data centers; and support online business operations. Business customers are also still converting to off-premise, subscription-based software, which helps them contain costs. The subscription model also adds visibility to software company earnings, which takes away some of the risk.

Vandeventer cites the following companies as beneficiaries of these trends: ServiceNow NOW, Shopify SHOP, Workday WDAY, Paycom Software PAYC, Okta OKTA,  Twilio TWLO, and Paylocity PCTY,  “It’s hard to argue these are undiscovered. But this is the best place in tech to be invested,” he says. All are among the 20 largest holdings in his fund.

Landis singles out Nutanix NTNX, which offers data center management software. Inventors are worried that giants like Dell Technologies DELL, and Microsoft MSFT, are moving into this space. But Landis says the concerns are overblown. “Nutanix has taken a beating lately, unjustifiably so.”

False Fear No. 4: The Pain of Getting ‘de-FAANGed’ Will Return

For anyone who did that hard work of analyzing companies during 2017-2018, it was a frustrating time. In reality, all you had to do back then was dumbly own the FAANGs, and you posted some of the best gains around.

This groupthink turned Facebook FB, Apple AAPL, AMZN, Netflix NFLX, and Alphabet GOOG, GOOGL, into the proverbial crowded trades. Like all crowded trades, they eventually tanked hard in late 2018. Many investors got burned. So now they don’t like tech.

True, there are legitimate concerns. Social media and search giants are getting attacked from the right and the left for free speech and privacy violations. Jeffrey Gundlach of DoubleLine Capital thinks the party is over at Facebook because regulators are on the scene. Hardly a day goes by without another article repeating the cliché that young people are fleeing Facebook.

But the current skepticism toward these names makes this a time to buy them. “The FAANGs all below their 52-week highs, and it looks like there’s an opportunity there to make money,” says Vandeventer.

Consider Facebook. “Facebook is pretty downtrodden in terms of sentiment,” says Vandeventer, who originally suggested Facebook in my investing column in the low $20 range when everybody hated it right after its IPO. Now, he thinks all the negativity is priced in, and the stock should move higher from here. “People think nobody uses Facebook anymore. But everybody is underestimating Instagram,” he says. Facebook is getting better at making money from Instagram, which will lead to upside surprises on profitability.

Google parent Alphabet is also hurt by privacy issues. And antitrust authorities in Europe have been cracking down. But Alphabet keeps delivering growth, in part because YouTube is so strong. Despite the growth prospects here, Alphabet trades for a forward P/E of 23. That is not much higher than the multiple commanded by lower growth consumer-staple companies like Coca-Cola KO,  which has a P/E of 21. “Alphabet and Facebook are still picking up advertising share from print and TV,” says Vandeventer. “They are cheap stocks. They are suffering more from poor sentiment than from their fundamentals.” tracks purchase and search patterns to target product suggestions, so it isn’t insulated from privacy concerns. And since it paid no income tax last year, it’s got a target on it in the political arena. “But they continue to execute and the company has a lot of moats,” says Vandeventer. This is the second-largest position in his fund.

Netflix shares are being held back by concerns that Apple is getting into streaming video, says Landis. But like prior concerns that Blockbuster, Walmart WMT, and would be devastating competitors, the Apple fears are overblown, he says.

False Fear No. 5: The Chips are Down

Semiconductor stocks are notoriously cyclical so they get hit hard on growth concerns.

“There’s usually a good counter trend segment within the chip industry that you can buy when people are dumping all their chip stocks,” says Landis. “Right now that is in power electronics.”

Chips that help manage power distribution are currently getting a demand boost because of big-picture trends like the 5G rollout, and the electrification of automobiles. “Getting juice to wheels is good old-fashioned electrical engineering, and it requires specialized chips,” says Landis. One play he likes here is Cree CREE.

Landis also likes Nvida NVDA, which he bought after it got stung by the bitcoin craze. Its chips were used in boxes that helped “mine” the cryptocurrency. So Nvidia shares temporarily went down with bitcoin BTCUSD, Landis still owns it. “They appear to be the most successful free-standing micro processing company in the business. They seem to be better at doing what they do than Intel INTC and AMD AMD gives you the impression that they have all the talent they need to keep coming up with new products.”

Marshall, at Hodges Capital, favors analogue chip makers in part because they now sell into so many areas beyond smartphones, PCs and videogame consoles — including cars, medical devices and industrial equipment. “This doesn’t make the business noncyclical, but it smooths out the cyclicality so that you don’t get the big swings that you have had in the past. Here, he likes Texas Instruments TXN, Cypress Semiconductor CY and NXP Semiconductors NXPI.

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